Our bank (not fitting the rural/underserved definition) does a fair amount of balloons currently. We are going to be shifting our focus into doing as many as we can after January 2014 as ARMs so that they can be QM's. I have a few questions:

1. Do you think 5/1 ARMs with a 2% periodic adjustment cap is acceptable?
2. What do you consider to be an acceptable lifetime cap?

For #2 I was thinking a lifetime cap of 6% to stay consistent with the secondary market but management is wanting to either increase this (not saying for sure how much but would like 8-10% I would guess) or have no cap. It is my understanding that not having a cap is not really an option because 1026.30 requires a max interest rate to be disclosed.

1. 5/1 ARMs are o.k. Just make sure the lenders factor in the payment increases when determining the ability to repay.

2. You are only limited on the lifetime cap by your states usury laws. If management doesn't choose a cap less than state usury limit, disclose the state usury limit as the cap.

1. That is the standard but you can have a higher cap if you wish.

2. As you point out you do have to disclose what the maximum rate would be. In most cases where a lifetime cap is not disclosed the maximum rate is generally the maximum rate allowed by state law.

In calculating the ATR, I think I may be confused. I thought you would use the largest P&I payment within the first 5 years after the first payment. Maybe this is for balloons only though??

If this is not right, how would you calculate the payment amount for ATR? The payment amount at the highest interest rate?? Seems extreme if that is the case.

"Just make sure the lenders factor in the payment increases when determining the ability to repay."

In relation to Section 32 and Section 35 loans, if applicable.

So for calculating the ability to repay under the new rules, for a 5/1 ARM that doesn't have an introductory or teaser rate what payment amount would you use to recalculate debt to income? The initial payment amount?

Just make sure you follow the actual disclosure rules:

8. Manner of stating the maximum interest rate. The maximum interest rate must be stated in the credit contract either as a specific amount or in any other manner that would allow the consumer to easily ascertain, at the time of entering into the obligation, what the rate ceiling will be over the term of the obligation.

i. For example, the following statements would be sufficiently specific:

D. The maximum interest rate will not exceed X%, or the state usury ceiling, whichever is less.

ii. The following statements would not comply with this section:

C. The interest rate will not exceed the state usury ceiling which is currently X%.

Thanks for the responses. I still am unclear on DTI calcs. For calculating the debt to income on a 5/1 ARM (with no introductory or teaser rate) do we just use the P&I payment at consummation?

(iv) For which the creditor underwrites the loan, taking into account the monthly payment for mortgage-related obligations, using:

(A) The maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due

So for a true 5/1 ARM, if our interest rate at origination was 5% with a 2% increase cap, we would underwrite the loan using the payment amount at 7%, correct?

FYI...I talked to an attorney at the CFPB who confirmed that the method I mentioned in my last post is how you would treat a 5/1 ARM.

I was busy focusing on the fully indexed rate piece and missed this cap piece. So if we have a 3/1 ARM with no cap we would have to calculate the DTI using the state usury rate?

B) Determines the consumer's repayment ability using the largest payment of principal and interest scheduled in the first seven years following consummation and taking into account current obligations and mortgage-related obligations as defined in paragraph (a)(4)(i); and

Bank Loan: 20 year loan with 5 year ARM
Index Rate prime 3.25% plus margin 2% = 5.25% fully indexed rate
State maximum lifetime rate 16%
Does the bank underwrite the loan with the P&I at 5.25% or the
16%?